No Good News for Morgan Stanley

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Surprise, surprise: Another investment bank reported a disastrous quarter.

Morgan Stanley (NYSE: MS  ) posted a fourth-quarter loss of $2.3 billion, or $2.34 per share. That was actually an improvement over the $3.61-per-share loss in the year-ago period. For the full year, net income came in at $1.7 billion, or $1.45 per share, down from $2.98 per share in 2007.

The full-year results aren't that bad, but the net income comparison is skewed. For one thing, last year's numbers include Discover Financial Services (NYSE: DFS  ) ; for another, the investment banking world has been utterly dismantled in just the last few months. Don't be surprised if the latest quarter's results paint a better picture of what Morgan Stanley looks like going forward. Ditto for Goldman Sachs (NYSE: GS  ) , which reported dismal results yesterday.

One hint of hope came from a drop in the leverage ratio, from 32.6 last year to just 11.4 today. That's good in terms of risk management, but jettisoning risk from the investment banking world is a double-edged sword for investors. How much of recent years' outsized profits simply resulted from successful gambles juiced by suicidal amounts of leverage? Too much to feel comfortable about the earnings potential of these companies, that's for sure.

If Morgan Stanley really is retreating from the old investment banking model, what's next? Now that it's a bank holding company, its obvious move is a merger with a commercial bank, which would turn it into somewhat of a JPMorgan Chase (NYSE: JPM  ) or a Bank of America (NYSE: BAC  ) . Both commercial banks still have substantial investment banking operations.

Which bank might be a marriage partner? The low-hanging fruit has already been picked, now that Wachovia has been swallowed up by Wells Fargo (NYSE: WFC  ) . The only options left are regional banks, which might not be large enough to make a dent on Morgan Stanley's balance sheet, or something big and bold, like a merger with Citigroup (NYSE: C  ) .

The latter would be pretty darn interesting. Citigroup -- struggling on its own -- probably needs to find a partner, and Morgan Stanley could desperately use Citi's commercial banking assets to distance itself from the short-term funding market. Taking two pieces of dung and slapping them together typically won't get you very far, but then again, banks are running out of options these days.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. JPMorgan Chase and Bank of America are Motley Fool Income Investor picks. Discover Financial Services is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletter services free for 30 days. The Motley Fool is investors writing for investors.

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